Burger King F3Q08 (Qtr End 3/31/08) Earnings Call Transcript

Burger King Holdings, Inc. (BKC)

F3Q08 Earnings Call

May 1, 2008 10:00 am ET

Executives

Amy Wagner - Senior Vice President, Investor Relations and Global Communications

John W. Chidsey - Chief Executive Officer, Director

Ben K. Wells - Chief Financial Officer

Russell B. Klein - President- Global Marketing Strategy and Innovation

Analysts

David Palmer - UBS

Steven West - Stifel Nicolaus

Matt Difrisco - Oppenheimer

John Glass - Morgan Stanley

Steven Kron - Goldman Sachs

Jeffrey F. Omohundro - Wachovia Securities

Jeffery A. Bernstein - Lehman Brothers

John Ivankoe - JPMorgan

Mitchell Speiser - Buckingham Research

Joseph T. Buckley - Bear Stearns

Presentation

Operator

Good day, ladies and gentlemen. Thank you very much for your patience and welcome to the Burger King Holdings third quarter fiscal 2008 earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Ms. Amy Wagner, Senior Vice President of Investor Relations and Global Communications. Please proceed.

Amy Wagner

Thank you and good morning, everyone. Welcome to Burger King's third quarter fiscal 2008 earnings conference call. We have prepared an earnings call PowerPoint presentation to assist in presenting our third quarter performance. These slides, as well as the audio broadcast of this call, may be accessed through our investor relations page on our website at www.bk.com. Both the audio portion and the slideshow will be archived on our website where it will be available for future reference.

Presenting on the call today are John Chidsey, Chief Executive Officer, and Ben Wells, Chief Financial Officer. Also with us on the call is Russ Kline, President, Global Marketing Strategy and Innovation, and he will be available to answer any questions you have about our marketing, advertising and products during the Q&A portion of the call.

We’ll spend about 20 minutes today discussing our third quarter results before opening the call for questions.

Before we begin today, I would like to remind everyone that this conference call includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect management’s current expectations based on currently available data. However, actual results may be impacted by future events and uncertainties and could differ materially from what is discussed today. More detailed information about these uncertainties is contained within the Safe Harbor statement included in this morning’s earnings release.

The presentation also includes non-GAAP financial measures as defined by Regulation G. The reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures and other information required by Reg G are included in the appendix to this presentation.

With that, I’d like to turn the call over to John.

John W. Chidsey

Thank you, Amy. Good morning, everyone and thank you for joining our call. During today’s update, we will discuss our strong quarterly worldwide results and our outlook for the rest of fiscal 2008. We will then open up the call for questions.

Our worldwide momentum continued into the third quarter. We delivered on our global growth initiatives with all segments posting robust quarter over quarter results. We remain on course, posting incremental improvements across all our strategic growth pillars -- marketing, products, operations, and development. We present highlights of our results on page three of the presentation.

Worldwide revenues increased 10% to $594 million compared to $539 million in the same quarter last year. We now have over four years of black on black worldwide comp sales. With 5.8% comps, we posted our 17th consecutive quarter of positive performance. We leveraged our product pipeline and marketing initiatives around the world while creating a consistent and positive guest experience at every restaurant. The current macroeconomic environment did not impact our top line performance as consumers continued to seek our quality, convenience, and affordability.

In the U.S. and Canada, we recorded comps of 5.4%, our 16th consecutive quarter of positive results. The success of the innovative Whopper Freak-out media campaign continued through January. During the quarter, our two-tier menu or our barbell strategy continued to boost sales. We featured premium indulgent products, including the Barbeque Bacon Tendercrisp Sandwich, as well as value menu offerings such as the Spicy Chick'n Crisp and Whopper Jr. Sandwiches.

In addition, we drove incremental family traffic with promotional tie-ins with classic children’s characters such as Snoopy and Spongebob.

In EMEA, we continued our margin boosting premium products strategy with indulgent offerings such as the Three Pepper Angus Burger and LTOs such as Chorizo Angus.

In Asia-Pacific and Latin America, we focused on our barbell menu strategy as we featured products such as the Ultimate Double Whopper and promoted our snacking category.

We opened 60 net new restaurants during the quarter and now have 254 more Burger King restaurants open than we did last year at this time. In the U.S., we posted positive net growth for the first time in six years and momentum is expected to build.

We continued to create brand awareness in China through the opening of three franchise airport locations, including one in the Beijing Airport, which will expose millions of passengers to our brand this summer in connection with the 2008 Olympics.

Development in existing countries is on course. We opened the first restaurant in Colombia and we entered a new country through awarding development rights to a franchisee in [Corasow]. We are confident in our ability to meet our development objectives for the fiscal year and I am happy to announce that as of April, we now have more restaurants open than at any time in the brand’s history.

Worldwide average restaurant sales increased 10% to $313,000 compared to $284,000 in the same period last year. Trailing 12-month average restaurant sales is now at $1.3 million and company ARS at $1.4 million, both new record highs.

Our quarter’s highlights continue on to page four -- our 10% revenue growth yielded a 27% increase in EBITDA to $107 million versus $84 million in the same quarter last year, clearly demonstrating the leverage of our fixed cost franchise model.

Diluted earnings per share increased 20% to $0.30 compared to $0.25 in the same period last year. Our earnings reflect $3.3 million in additional expense, primarily related to the accelerated depreciation of our previously announced restaurant reimaging initiative in the U.S. and Canada.

Earnings were also negatively impacted by an additional net expense of $3.5 million primarily due to strategic portfolio management predominantly in our EMEA markets. These additional costs were offset by a $9 million gain resulting from refranchised restaurants in Germany, also part of our ongoing portfolio management. On a combined basis, these items positively impacted earnings by $0.01.

The effective tax rate for the quarter was 36.9% compared to an unusually low tax rate of 24.4 in the third quarter last year. Last period’s tax rate benefited primarily from the acceleration of benefits derived from the operational realignment of our European and Asian businesses.

During the quarter, we used our balance sheet to enhance shareholder value for each of our identified strategic purposes. First, we declared and paid a quarterly dividend of $0.0625; second, we opportunistically repurchased approximately 1 million shares, or $26 million under our previously announced $100 million share repurchase program; third, we continued our plan to significantly increase restaurant level profitability through our reimaging efforts in the U.S. and Canada.

I am also pleased to announce that in accordance with our strategic plans, we completed a 56-restaurant acquisition in the Carolinas with one of our largest U.S. franchisees, Heartland, this past month. The transaction enables us to develop and grow our company portfolio in an attractive existing company market and enables Heartland to manage a more geographically concentrated restaurant base.

Turning to page five of the presentation, worldwide revenues increased 10%, driven by an 8% increase in company restaurant revenues and an 18% increase in franchise revenues compared to the same quarter last year.

This quarter’s strong top line expansion was driven by solid comps in each reporting segment and net restaurant growth. Worldwide company restaurant margin decreased 80 basis points to 13.2% from 14 in the year-ago period, driven by margin declines in the U.S. and Canada. Company restaurant margins improved in EMEA Asia-Pacific and remained unchanged in Latin America.

The aggregate decrease was primarily driven by higher commodity costs and expenses associated with the company’s previously announced U.S. and Canada reimaging initiative. Robust comparable sales in all reporting segments minimized the impact of higher costs on company restaurant margin.

G&A expense was in line with guidance, growing at a rate of 3% net of foreign exchange impact of $5 million. Our continued ability to hold G&A within inflationary levels demonstrates our discipline and capacity to drive top line sales and development while aggressively managing the expenses.

Our worldwide blended royalty rate continued to climb to 4% as we opened more U.S. franchise restaurants at the 4.5% royalty rate and as we brought on more international franchise restaurants at the standard contractual rate of 5%.

Page six of the presentation contains fiscal 2008 year-to-date results. We have delivered solid performance as evidenced by our year-over-year substantial improvements. Compared to the same period last year, revenue is up a strong 10% at $1.8 billion from $1.6 billion. EBITDA is up 20% at $342 million compared to $284 million, and diluted earnings per share is up 23% at $1.01 versus $0.82.

We are generating top of the industry performance and I am confident in our ability to continue our momentum as we execute on our multiple growth levers, including expansion into existing and new strategic markets, refreshing our restaurant base, market leadership in innovative promotions, a robust product pipeline, and operations excellence.

Page seven of the presentation details financial highlights by reporting segment. Worldwide revenues increased 10% and income from operations increased 31% over the prior year period. Strong comp sales and net restaurant growth largely drove our substantial improvements.

In the U.S. and Canada, revenues grew by 10% and income from operations increased 1%. Top line benefited from strong comps of 5.4% compared to 2.6% in the same quarter last year, marking the completion of four consecutive years of positive comp performance.

In addition, the segment posted positive net unit growth for the first time in six years, adding a net 15 restaurants. Our barbell menu strategy generated solid performance. Throughout the quarter, we featured our traffic driving AM and PM value menus, and our margin boosting premium products, such as Barbeque Bacon Tendercrisp Sandwich. We also drove incremental family traffic with targeted promotions.

Company restaurant margin decreased by 250 basis points to 13.1% from 15.6% compared to the same quarter last year. The decrease was impacted by 190 basis points of additional food, product, and paper cost and 120 basis points primarily from the expected accelerated depreciation cost of restaurants in the reimaging program. These higher costs were partially offset by our strong comp sales.

EMEA APAC revenues grew 10% and income from operations increased nearly three-fold to $26 million from $10 million in the same period last year. Foreign exchange positively impacted revenues and income by $19 million and $3 million respectively.

As part of our ongoing strategic portfolio management, revenue was negatively impacted by a net reduction of 38 restaurants during the past 12 months, including 28 refranchisings in the U.K. and Germany.

Earnings improvement was driven by robust comps of 6.8% versus 5.3% in the year-ago quarter, led by double-digit comp performance in the U.K. and Spain. And as mentioned, the refranchising of restaurants in Germany positively impacted performance by $9 million.

A focus on premium products and operational improvements in both EMEA and APAC fueled results. Net restaurant growth of 145 over the past 12 months also boosted bottom line performance. Company restaurant margins increased 230 basis points to 12% from 9.7% due to strong comps and to a lesser extent, the closure of under-performing restaurants. These improvements more than offset commodity costs and labor pressures.

In Latin America, revenues grew by 17% and income from operations increased 13%. Profitability expansion was largely driven by the opening of 95 net new restaurants over the last 12 months and by solid comps of 5.8% compared to 2.7% in the same quarter last year. The strong comp increase reflects continued strength throughout the South American and Caribbean markets.

A combination of premium and value products, such as the Angus ‘Shroom and Swiss and dessert value offerings fueled comps. Company restaurant margins remain unchanged at 23.6%, the highest margins globally.

Page 8 of the presentation includes year-to-date financial highlights by segment. Significant development and comp acceleration are yielding best-in-class results. All segments are contributing to top line and bottom line expansion. Our worldwide business momentum is strong, evidenced by our fiscal 2008 year-to-date results. Revenues and net income are up 10% and 24% respectively compared to the same period last year.

Page 9 depicts our company scorecard. We posted strong results across key measures as our global momentum continues to drive solid results. I will now take a few minutes to discuss our scorecard metrics.

Page 10 highlights comp sales on a worldwide and U.S. system basis. Our worldwide comp sales accelerated in the third quarter as we implemented our proven barbell menu strategy throughout most markets. We leveraged our product pipeline, including different builds of the Chicken Tendercrisp Sandwich and the Whopper around the world, along with our marketing initiatives, including Cabbage Patch Kids, Monster Jam, Spongebob, and Snoopy to drive family traffic across many markets.

In the U.S., January sales and traffic were fueled by the continuation of the innovative Whopper Freak-out media campaign. Throughout the quarter, we satisfied guests seeking both indulgence and value. We also featured popular children’s classics, driving incremental family visits.

In EMEA, we featured premium products and in APAC, we promoted quality, value, and convenience with offerings such as Ultimate Double-Whopper and Megacrunch Tendercrisp Sandwich.

And in Latin America, the Whopper Mania promotion continued, featuring four different builds of our iconic burger.

The fourth quarter is off to a solid start with strong April comps. In April, we launched innovative products including the Steakhouse Burger platform, featuring steakhouse quality ingredients, and the Cheesy Bacon BK Wrapper, the newest addition to our breakfast value menu, with both products exceeding our initial sales forecast.

The marketing highlights for the rest of the quarter will present our guests with the summer of adventure, including the launch of our Indy Whopper and Indiana Jones gaming promotion in May, alongside the highly anticipated Indiana Jones movie. We will also continue to innovate around the snacking day part, with both our Oreo Sundae Shake and Mocha BK Joe.

Now, Ben will update you on the rest of the metrics.

Ben K. Wells

Thanks, John and good morning, everyone. We are delivering top of the industry results by executing on our strategic growth pillars in spite of current challenging macroeconomic conditions. Our results highlight the strength and relative inelasticity of our business and most importantly, we are committed to continuous improvement.

Let me turn your attention to page 11 of the presentation. This slide includes analysis of average restaurant sales, company restaurant margins, and royalty rate. Worldwide trailing 12 months system and company average restaurant sales hit new record highs of 1.3 million and 1.4 million respectively. We are excited about our revenue progress and are intensely focused on driving additional top line growth. As we continue our robust comp sales trends and unit expansion, and as the results of our reimaging initiative gain traction, I remain confident that our $1.5 million interim ARS goal is within reach.

Our highly fixed cost model within the restaurant magnifies the impact of incremental average restaurant sales on bottom line performance. For example, our U.S. company restaurants with trailing 12 month sales above $1.9 million are generating best-in-class margins of approximately 26%.

As John mentioned, in the U.S. and Canada company restaurant margin of 13.1% was negatively impacted by 190 basis points of food, product, and paper costs. These higher commodity costs were partially offset by our strong quarterly company comps of 3.5% in the region.

During the quarter, beef and chicken costs increased about 3% and cheese increased about 35% compared to the same quarter last year. Over the next six months, we expect beef prices to increase about 3% and chicken prices to remain approximately stable, benefiting from our fixed cost price contracts.

Bun prices are expected to increase approximately 10% as worldwide wheat inventories remain tight. Over the next six months, we continue to see commodity pressures impacting our cost of goods by 5% to 7%, or 150 to 210 basis points. Some of these cost pressures will be minimized as we anticipate taking price in our company restaurants in May.

During the quarter, we posted a significant improvement in our worldwide blended royalty rate, up 23 basis points at an all-time high of 4% quarter over quarter. This boost in the royalty rate was aided by approximately 300 U.S. franchise restaurants that migrated to the 4.5% level on December 31, 2007. These restaurants were at a lower royalty rate as part of an early remodeling incentive program which concluded this past calendar year. There are no more restaurants remaining in this plan. On a go-forward basis, the royalty rate accretion should be five to seven basis points per year.

Turning now to page 12, we effectively utilized our strong cash flow for each of our identified strategic purposes all geared towards enhancing shareholder value, including a quarterly dividend payment, share repurchases, and the reimaging of company restaurants. We declared and paid our fifth quarterly dividend of $0.0625 per share, returning $25 million to shareholders year-to-date.

We took advantage of broader market conditions and opportunistically repurchased approximately 1 million shares of our stock utilizing $26 million of our excess cash. Today, $68 million remains available under the $100 million share repurchase plan.

In the U.S., we currently have 27 active restaurants in the reimaging program. During last quarter’s update, we mentioned that these restaurants would have short-term negative impact on U.S. revenue and restaurant margins would be negative impacted by approximately $10 million to $12 million over the second half of fiscal 2008 due to the loss of sales resulting from temporary closures during renovations and accelerated depreciation from the disposable assets.

The initiative’s impact to the third quarter was $3.3 million, or $0.015 per share. We expect the improved traffic associated with restaurant reimagings will result in increases in sales beginning in fiscal 2009. In the fourth quarter, we now forecast a negative impact to company restaurant margins of approximately $6 million to $7 million from this strategic initiative.

Year-to-date, we have invested $79 million in building new and remodeling existing company restaurants, compared to the $39 million invested during the same period last year.

We are excited about the initial sales lift we are seeing from our company restaurant reimaging program. In conjunction with our overall portfolio management and desire to keep our approximately 90-10 franchise to company ratio model, we completed a 56-restaurant acquisition in the Carolinas with Heartland Southeast at the end of April. The transaction allows us to develop our company restaurant portfolio in that market by leveraging our established brand presence in existing infrastructure. As a result, we expect annual U.S. company restaurant revenues and EBITDA to increase by approximately $64 million and $9 million respectively on a go-forward basis.

Conversely, as a result of the German refranchised restaurants, we expect annual EMEA APAC company revenues and EBITDA to decrease by an estimated $20 million and $4.5 million respectively.

On a net basis, these transactions should yield an annual net increase for worldwide company revenues and EBITDA by approximately $44 million and $4.5 million respectively.

We are pleased with the strategic deployment of our excess cash during the quarter. Our cash flow generation enables us to enhance shareholder value by reinvesting in new and existing company restaurants, paying dividends and buying back shares in the open market.

Our third quarter effective tax rate was 36.9% as compared to a year ago’s quarter effective tax rate of 24.4%. Last year’s tax rate was positively impacted by one-time adjustments in tax accruals and by the accelerated depreciation of benefits derived from the operational realignment of the European and Asian businesses. This lower tax rate benefited last year’s earnings per share by approximately $0.035.

We continue to anticipate a full fiscal year effective tax rate absent future discrete items of approximately 37.5%.

Before turning the call back over to John, I want to mention that we have once again included additional data and reconciliations in the appendix of the presentation. Thank you for your interest and participation in our call. John.

John W. Chidsey

Thanks, Ben. I am proud of our team’s accomplishments year-to-date. We have stayed focused on our strategic pillars and have delivered higher-than-planned results despite economic pressures.

I am also pleased that we have closed on one of our target acquisitions and have begun our reimaging program, which as Ben said is expected to yield significant results.

We remain on target to open approximately a net 300 restaurants and our average restaurant sales continue to draw closer to our interim $1.5 million goal.

Based on our solid three quarters of performance this fiscal year and the momentum we see continue into our fourth quarter, we are raising our fiscal ’08 full year revenue growth guidance to 10% and earnings per share guidance to be in the range of $1.33 to $1.35, representing a 20%-plus growth over the prior year period.

I thank everyone for their continued support and interest and at this time, we will open the line for any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of David Palmer with UBS.

David Palmer - UBS

I wanted to ask you with regard to your pricing, are you going to try to target offsetting that high 100s to low 200s basis point impact from commodities fully?

John W. Chidsey

Well, obviously David, we have the marketplace which, whether we like it or not, dictates what we can do so we have only taken pricing I think as you know in this fiscal year, we talked about it on the last call, of 80 basis points back in November, and we talked about that we had certainly been less aggressive than a lot of our competitors, given our value -- and some of the issues that we’ve been working against over the last two or three years.

So I think it’s just very much driven by the marketplace and we are out there gathering data now and we’ll come to the determination as to how aggressive we can be given commodity costs, but also recognizing again that we need to continue to be mindful of our value opportunities.

David Palmer - UBS

With regard to the reimaging, just one follow-up; you mentioned $6 million to $7 million of expense in the fourth quarter associated with taking restaurants out of commission to reimage them. How should we think about that for fiscal ’09? And are these reimagings a direct result of oftentimes these acquisitions -- does that -- are oftentimes these reimagings of these acquired restaurants? Thanks.

John W. Chidsey

Most of the reimaging is coming from our existing portfolio, not from these acquisitions. And as we said -- again, I can’t remember if it was the last call or two calls previous to this, we have 300 restaurants roughly that are over 30 years old in our existing portfolio of 755 in the U.S., so we said over the next four to five years we wanted to either do substantial remodels or actually just scrape them and rebuild them. So this was year one of that and so next year you might see a mild step-up but basically we should hit steady state to be off by $2 million to $4 million, but roughly it should just be a recurring $10 million. So you are not going to see $10 million to $12 million. You are not going to see a big swing next year or the year after.

Anything I miss there, Ben?

Ben K. Wells

No, that’s essentially it. The uplift that we are going to see from the existing portfolio was the first tranche of this program should largely compensate as we lose the restaurants that are remodeled as we go forward. So we are hopeful that -- we are going to give guidance as we begin through our planning process at the end of the year as to where we are going to be on that remodeling, but essentially as John has described is what we think right now.

David Palmer - UBS

Thank you very much.

Operator

Your next question comes from the line of Steve West with Stifel Nicolaus.

Steven West - Stifel Nicolaus

I just had a quick question on same-store sales comps. Can you talk about -- in the past you’ve talked about the traffic versus price in the comp. Are you still seeing about a two-thirds increase traffic on that?

And then also a follow-up, kind of what David was asking with the remodeling, do you see these added expense as being kind of a hindrance going forward to your long-term earnings growth of 15% at least? Thanks.

John W. Chidsey

As to your first question, it continues to be a very healthy balance of check and traffic. I’d say it is still slightly skewed towards traffic, meaning slightly predominant. So we are still in that 50 to two-thirds range, certainly in the U.S. and if you look out globally, I am confident the number is the same. I can’t -- it’s more than 50% traffic outside the U.S. as well.

As to your second question, no, we do not expect that to have any impact on where the street has us for long-term earnings per share growth again because we will be in a steady state where it is constantly revolving and given the results, we continue to see the 16% to 20% on the remodels and the roughly 26% on the scrapes, so as long as we continue to see those results, we’ll continue to move forward with that program and it has very attractive financial returns that as shareholders we should all be happy about.

Steven West - Stifel Nicolaus

Thank you.

Operator

Your next question comes from the line of Matt Difrisco with Oppenheimer.

Matt Difrisco - Oppenheimer

Thank you. Can you just give us some visibility around how we should model the other income line and given that you are still in the process of doing some more franchise sales, both domestically and internationally, how we should look at those gains?

John W. Chidsey

Well, basically our guidance right now is to recognize is that we are constantly managing our portfolio of restaurants and it is going to ebb and flow around that number but essentially that is a -- frankly a volatile number. I would basically try to keep it as close to zero as possible, allowing for the fact that we will be doing ins and outs inside that space.

Matt Difrisco - Oppenheimer

Okay, and then I’m sorry if I missed this but can you give us an update on how many of your franchisees are in the process and some milestones maybe that you are looking at for the rollout of the new broilers?

John W. Chidsey

We have -- in the U.S., I think we are at about 25% -- worldwide, sorry, we’re at about 25% of our systems on the new flexible batch broiler. The U.S. we are a little bit higher. We’re about 33% in the U.S.

Matt Difrisco - Oppenheimer

That’s system or franchise? I mean, obviously you are pretty much franchised, but that’s franchise, correct?

John W. Chidsey

Yeah, that’s the system. We’ve got -- out of the 11,455 restaurants we’ve got, we’ve got approximately 2,900 either installed or in-process, which means basically they are going to be firing them up within the next month or so.

Matt Difrisco - Oppenheimer

And then the timetable to be fully completed?

John W. Chidsey

2010.

Matt Difrisco - Oppenheimer

Thank you.

Operator

Your next question comes from the line of John Glass with Morgan Stanley.

John Glass - Morgan Stanley

Two follow-ups and then a question; one is Ben, when do you expect to reach that steady state on remodeling in the U.S. such that it doesn’t have an incremental pressure on margins? Does it begin a year from now or is it less than that?

Ben K. Wells

Well, what we are hoping is these 27 that roll in the next two to four months, basically that will allow us to reach steady state next year as we move forward. And it’s our intent to try to design the program around the uplift that we are getting off of those restaurants, so this isn’t going to be by accident. This is hopefully going to be [plentiful] in our approach to the program.

John Glass - Morgan Stanley

Okay, so one more quarter, meaning the fourth quarter of this year, has that detrimental impact and then after that, we should start to see it normalize?

Ben K. Wells

That’s correct.

John Glass - Morgan Stanley

Okay, and then with respect to your commodity comments of up 150 to 210 basis points, was that before the pricing you are going to take in May or is that after?

Ben K. Wells

That’s obviously looking back behind us, so it would be before.

John Glass - Morgan Stanley

Okay, so you should see less commodity pressure in the fourth quarter and beyond, given your pricing?

Ben K. Wells

That’s the hope but obviously the commodities can take on a life of their own and obviously as you well know, a lot of the commodity pressures has been originating out of the value of a barrel of oil and the value of the dollar on broader markets. Both right now are trending back into our favor from a commodity perspective and with a little bit of luck, we will see moderation of the inflation inside the next 90 to 120 days. But looking out beyond that, I don’t think commodity inflation as something in the past. It is something very much in the future.

John Glass - Morgan Stanley

Okay, and then the question is do you intend to expand operating hours again this summer or not?

Ben K. Wells

Russ, you want to take that one?

Russell B. Klein

Yes, we do. We have just recently communicated out to the system that June 1st I believe is the date -- am I right with that, John?

John W. Chidsey

Correct, June 1st.

Russell B. Klein

June 1st -- we are going to 6:00 a.m. required hours of opening, six days a week and Thursday through Saturday, 2:00 a.m. or later. So that will allow us to pick up the equivalent of about another five hours on what has been somewhere around a 13, 14-hour disadvantage and should get us into high single digits now and in striking distance of where we feel we need to be competitively.

John Glass - Morgan Stanley

And I know not all hours are created equal, so if those five hours, what do you think the incremental comp benefit would be this summer?

Russell B. Klein

Well, our general rule of thumb has been a five-hour gap is worth a hypothetical comp point, so breakfast operates as you point out a little bit differently than late night but we think that with the growth of our breakfast value menu, some of the innovation around wraps, and then what we are continuing to just see to be a more straightforward business case on the Thursday through Saturday 2:00 a.m. hours, we think together they should generate the equivalent of about that comp point contribution.

John Glass - Morgan Stanley

Thank you.

Operator

Your next question comes from the line of Steven Kron with Goldman Sachs.

Steven Kron - Goldman Sachs

A few questions; one, I guess a couple of things related to the buying back of the 56 stores in the U.S., the franchise stores. I know that is part of your strategy but can you just give us a little color -- were these stores up for renewal, are there others that are targeted currently that’s in the pipeline that we should expect to flow through over the next couple of quarters? And I think ultimately you want to maintain that 90%, roughly 90% franchise, 10% company so how should we be thinking about any refranchising plans down the road, maybe to break it up to smaller groups of franchisees that are more growth oriented?

John W. Chidsey

The way to think about it, Steve, one of the things we’ve articulated over the last year, and it’s certainly gone slower than we wanted it to, is that we wanted to take some of our larger franchisees and try to break them up and A, diversify your risk by getting them into the hands of more franchisees and certainly get more development out of them, and this was an example. Heartland is one of our top three or four franchisees and this was a way to substantially reduce their size. This particular group of restaurants they had fit very well within our existing company footprint, so as opposed to selling those off to a franchisee, we just absorbed them there.

But as Ben said, we sort of look at our portfolio over time and there will be lots of ins and outs, and I think I’ve been very clear quarter after quarter that you could see us spike a percent or two here or there, but over the long run we should stick with that 90-10. So I am not sure we could say to you model X, Y, or Z each quarter. It will never jump from 10% to 15% in the quarter. That’s just impossible, given the numbers of our company portfolio. But you could see us 30 or 40 go the other way some quarters.

So that’s how I’d look at it.

Steven Kron - Goldman Sachs

And then on the franchisee side of things, clearly leaning on them a lot for development down the road. We’ve heard from a lot of companies out there the current credit conditions are making it a bit more challenging for franchisees to get access to capital to do perhaps what they want to do. Are you seeing any of that and should we be thinking about any inhibitor to franchisee being able to access capital to grow?

Ben K. Wells

Well, the answer to that right now is that frankly we have not had anyone saying that they can’t get access to capital per se. However, we continue to monitor the situation very closely. If we need to, we’ll begin to evaluate different alternatives in and around that particular question. But frankly, there’s a lot of pundits out there that are arguing we may have bottomed out on this credit squeeze cycle. There’s others that are arguing we haven’t.

So we are going to continue to monitor it very, very closely. Steven, as you know when we talked last, this was top on the agenda on everybody’s mind here at Burger King and it continues to be.

Steven Kron - Goldman Sachs

Okay. Thanks very much.

Operator

Your next question comes from the line of Jeff Omohundro with Wachovia.

Jeffrey F. Omohundro - Wachovia Securities

Thanks. You had some new efforts at breakfast, such as the Cheesy Bacon BK Wrapper, but I’m curious that now that you are lapping the introduction of breakfast value from last year, where your thinking might be around additional innovation perhaps needed to maintain breakfast day part momentum, what your thoughts are around that.

John W. Chidsey

Russ, you want to take that?

Russell B. Klein

Sure. Well, we have a full pipeline for the breakfast day part. Certainly the breakfast value menu has continued to grow for us and it has continued to help us grow the breakfast day part, and so that will continue to be an important ingredient in that day part. The wrap business will be a platform that will provide us with additional variety down the road unquestionably, both at a.m. and p.m. And we have a number of other protein-based main meal entrée offerings available that we are test-marketing right now.

So we are confident that we’ve got as much innovation as we need and that is a day part where our restaurants can handle a little more menu complexity going forward as well.

Jeffrey F. Omohundro - Wachovia Securities

And can you give us the status of the testing on the rollout of the new kids menu?

Russell B. Klein

Well, we are complying with the food pledge that we signed in collaboration with the Better Business Bureau. We have a Mac and Cheese, Kraft Mac and Cheese and Apple Fries kid’s meal that is in compliance with all of the nutritional metrics, and that will be rolling into the restaurants this summer. So we are on target there and we are excited about not only that initiative but what Apple Fries represents as an all-family product. We see that actually the majority of that particular product is going out a la carte and being consumer by adults as well.

Jeffrey F. Omohundro - Wachovia Securities

Very good. Thanks.

Operator

Your next question comes from the line of Jeff Bernstein with Lehman Brothers.

Jeffery A. Bernstein - Lehman Brothers

Thank you. Two questions, first just focusing a more on the international strength; just wondering first of all if you could talk about any particular market outlayers on either side. There’s been lots of talk of the U.S. weakness spreading overseas, yet I think you mentioned the U.K. you were seeing comps up double-digits. And actually specific to the U.K., just wondering whether you can give us an update on the improvement to the revitalization whether in terms of metrics on store closures, margin contribution, things of that nature. And then I have a follow-up.

John W. Chidsey

I would say that globally, as you can see from the numbers, it was a very strong performance, whether you looked in Latin America, whether you looked in Asia, whether you looked in Europe. It was very broad-based and we did highlight the U.K. and Spain both being up double-digit, but there were no markets that were in the tank or that would lead you to question what’s going on in the macro environment in a Germany or a Turkey or Australia or any of our other large markets. So I think what we were pleased about was just the breadth of the performance around the globe in all those regions.

In terms of the U.K. specifically, there were very few closures in the last -- in the quarter, I think less than a handful, like single digits. We’re through that part of the process for the most part and in the U.K., we are now beginning to lap the one-year performance of the turnaround in the U.K., which is obviously another good sign.

I don’t know what your second question is but hopefully that answered the first one.

Jeffery A. Bernstein - Lehman Brothers

Actually, just looking more at the U.S. business, kind of the broader QSR landscape, it seems like the competitors are pushing more value. I’m just wondering whether you guys are shifting more marketing support around value. And then actually I think separately you mentioned that April was looking strong and I didn’t know whether strong meant that that was running in line roughly with the third quarter or kind of trendwise relative to the third quarter. Thanks.

John W. Chidsey

Russ can jump in here but the answer is no, we are not devoting any -- a bigger shift of marketing dollars or emphasis behind the value menu. As you now, our value menu is still underdeveloped in terms of percentage of sales compared to our competitors, and given that it does have the superior blended margin, that is certainly an opportunity but we are very happy with the mix that we have and the formula between premium priced products in the menu, so we are going to -- the value menu and we are going to continue to sort of run for the foreseeable future as we have over the last three to five quarters.

Is there anything else you want to add there, Russ?

Russell B. Klein

I would just reinforce it. It’s a twin engine strategy in terms of the menu, so the work that’s in the marketplace right now with the Cheesy Bacon breakfast wrapper is of course a value play at the breakfast day part and it will have a partner in the p.m. later on in the summer, and it’s going very well for us, as is the Steakhouse burger, which is very premium priced and elevated quality. So you will continue to see both facets of that played out in the market.

Jeffery A. Bernstein - Lehman Brothers

And the comment about the strong April comps, is that similar to 3Q trends or --

John W. Chidsey

Yes, as we said, April is off to a very good start from a comp perspective and we certainly have seen no deceleration in terms of what we experienced in the third quarter, so we are very happy with how the fourth quarter is shaping up so far.

Operator

Your next question comes from the line of John Ivankoe with JPMorgan.

John Ivankoe - JPMorgan

Firstly I think a number of actually pretty short questions -- there was actually a difference between a company store performance and system-wide store performance in the U.S., I guess right around two points. Could you provide some color as to why that was?

John W. Chidsey

I think a lot of that is when you look at -- because remember, our company restaurants are all east coast based. We have nothing west of the Mississippi, and so if you actually look at like for like DMAs, you would see that there is very little difference within them. We obviously don’t break that out but that’s what really counts for it. It’s mostly just geographical differences within the country.

John Ivankoe - JPMorgan

Okay, and secondly, obviously you’ve done some remodels and rebuilds in the company system, presumably before this quarter or perhaps even during this quarter. Could you talk about what the actual sales lifts have been as you’ve been putting this program in place?

John W. Chidsey

I don’t think we’ve seen any change. I think we will be in a much better position to answer that over the next quarter or two but certainly the preliminary data that we’ve seen so far would still indicate that 16% to 20% on a remodel and 36% on a scrape and rebuild continues to hold. So that’s something we can certainly give you some more color on in the next two quarters but we should have a lot more data at that point than we do now.

John Ivankoe - JPMorgan

Okay, that’s helpful. And finally just to understand about your May pricing, is this some of the location based pricing that we were hearing about that might be an opportunity for you, or is this more of a system-wide price increase that you are taking?

John W. Chidsey

I would say it’s a little bit of both. I mean, we are starting to roll out the -- as we call it, the market based pricing, if you will. So I would say it’s a little bit more of a rifle approach than just a shotgun blast across the country.

John Ivankoe - JPMorgan

Okay, but the market based pricing still might give you -- that still might provide you a future opportunity at this point? It sounds like it is still a relatively new program.

John W. Chidsey

Absolutely. I mean, it’s going to take us a good four to eight quarters to get that completely rolled out, so I think that’s another that Russ and I have talked about at conferences and on the call, that it’s going to take us time as we build our database and fully implement this not just across our company restaurants but then assuming we like what we see, which I am highly confident we will, that’s something that we’ve said we would like to offer to franchises and I think they will fully embrace that. So I think it will take, like I said, a good four to eight quarters to be fully saturated, if you will, throughout the country.

John Ivankoe - JPMorgan

All right, great. Thanks, John.

Operator

Your next question comes from the line of Mitchell Speiser with Buckingham Research.

Mitchell Speiser - Buckingham Research

Thanks very much. I’ve got a few questions. First on the reimaging, could you just give us a sense of the U.S. company stores, what percent has been reimaged? And then when it comes to franchise stores, what percent is required to get upgraded on an annual basis?

John W. Chidsey

Okay, I’m going to say of the company portfolio that’s recently been reimaged -- and when I say recently, in the five years let’s say since we appeared on the scene, or since the sponsors bought the company -- I’d say it’s somewhere between 5% to 10% of the portfolio, so that’s -- you know, one of the reasons we talked about, it’s obviously a very successful tactic for McDonald’s in their Plan to Win over the last five years and again, looking at the age of our restaurant portfolio and seeing the sales results we got, that’s why we substantially upped our CapEx this year. And again, as long as the numbers hold through, we’ll continue at that pace for the next three to five years until we can get our portfolio where we would like it to.

In terms of franchisees, I think you know that in our franchise agreement, which are typically 20-year agreements, at year 10 you must do something which is known as a mid-term remodel, which is anywhere from $80,000 to $140,000, $150,000 remodel. But your substantial one is at the end of 20 years when you re-up for another 20-year agreement. Those can be anywhere from $300,000 to $500,000 and are fairly substantial in scale.

So when you say how many of those, every year roughly 5%, given that we are on a 20-year agreement, come up for renewal. So out of 6,500 franchise restaurants, you have about 325 of those coming up for renewal every year and those would be the ones that you would have the substantial remodel.

Mitchell Speiser - Buckingham Research

Great, thanks. And my next question is on international where your international comps have been great, yet you look at other multi-nationals like Yum! and McDonald’s, even Domino’s, there seems to be a global up-tick in fast food sales and I guess, putting aside maybe your company specific strategies, could you maybe discuss some of the fundamental changes that maybe are going on outside the U.S. that are driving this global up-tick in quick-service same-store sales?

John W. Chidsey

I’ll take a stab and Russ can certainly help paint the picture. Again, I think it’s very region specific, the story. I mean, if you look in lots of parts of the world where you have developing economies and you have more and more people that are moving into the middle class and are coming into our space, that’s been a big benefit in lots of countries in Asia for us. Certainly the same could be said for Latin America, in a lot of our markets there.

In Europe, I think you have a lot of the same pressures we have here, meaning that macro trends and disposable income are somewhat under pressure at the moment. I think people are more trading for value, to a certain extent.

And then lastly, I just think is everybody -- you know, I think one of the things the industry as a whole has done well globally has really innovated the quality of their product offerings, and I think you are just attracting more and more people globally, not just in the U.S. to the space, given the quality improvements not just in the products but also in the operations.

Is there something else, Russ, that you can --

Russell B. Klein

The only thing I would add on to that, John, is the time-starved component, which is sort of an evolution at a different cycle in prospering economies, increasing middle classes, more disposable income in those countries, and convenience becomes a more compelling proposition, matched up with the quality that John just referenced and you get that kind of intersection where we are in the sweet spot.

Mitchell Speiser - Buckingham Research

Great, thanks. And I just have a couple of quick others -- just on the other income line, I think you mentioned to model it as kind of flat on an annual basis. Third quarter to date, it is I guess a swing of $6 million in income, so does that view apply for the fourth quarter, to expect more of an expense flowing through that line in the fiscal fourth quarter?

Ben K. Wells

Well, essentially fourth quarter will take care of itself but the answer, we already announced that we had a transaction coming through with the Heartland acquisition that will have certain OI&E impacts, but without pre-announcing any other activities that we may do, and the reason we are trying to be that way, guys, is frankly these are under negotiation and commenting publicly about them can influence those transactions and it would not be in the best interest of our shareholders to telegraph elements of that.

Mitchell Speiser - Buckingham Research

Okay, and my last question, just on the selling expense, I believe it was up 16% year over year. It’s bounced around a bit over the quarters but how should we think about modeling the selling expense on a bigger picture basis and perhaps more specifically in the fourth quarter? Thanks.

John W. Chidsey

Well, two things; first of all, it is formulaic in the way it works and basically you also have the currency flowing through that line, so once you strip out the movement in the currency, you are basically going to see about $2 million -- excuse me, you are going to see it tie based on the three percentage points -- I said $2 million. My brain went dead. Three percentage points as it flows through on the program.

Mitchell Speiser - Buckingham Research

Thanks very much.

John W. Chidsey

That’s just a -- as Ben said, that’s just a straight percentage of sales calculation other than the FX impact for company restaurants.

Mitchell Speiser - Buckingham Research

Got it.

Operator

(Operator Instructions) Your next question comes from the line of Joe Buckley with Bear Stearns.

Joseph T. Buckley - Bear Stearns

Thank you. A question for John or maybe Russ -- would you comment on the overall level of competitive pricing and discounting in the U.S., and maybe give us an update on the Double Cheeseburger test in that context?

John W. Chidsey

Russ, you can answer that one. I’ll take a stab --

Russell B. Klein

I’m sorry, I was on mute there.

John W. Chidsey

Okay. Go ahead.

Russell B. Klein

I don’t believe we are seeing any real pronounced increase in discounting per se. You see most of the players in this space use a complement of couponing and sampling and value menu and so I think we are a more evolved industry in that regard in terms of trying to create a value equation that continues to be profitable for the restaurants.

And the other part of your question, Joe, was --

Joseph T. Buckley - Bear Stearns

The Double Cheeseburger test that got a lot of media coverage I don’t know, six months ago or so?

Russell B. Klein

Well, we saw what we though we would see in the Double Cheeseburger test, which is we have a superior product and that’s a value for the money. That is a very compelling proposition and at this point, we are not going to disclose any of our potential plans to use it as a tactic at any point, but we have completed the test and we have the learning that we wanted.

Joseph T. Buckley - Bear Stearns

Okay, and then just one more, just on the refranchising in Germany -- just put that in context. Is that something we are going to see more of? What drove that decision?

John W. Chidsey

It’s really just looking at our portfolio kind of country by country and figuring out where we have critical mass and are there, again just like in the U.S., are there markets where we would be better off putting those restaurants in the hands of franchisees because we’d get more growth out of them, so we’ve really tried to geographically concentrate our company restaurant portfolio in Germany to a larger extent than what we previously had, and so again, I think we get two benefits. It just helps us be more concentrated, it gets more development done more quickly. So again, that’s why I sort of say I think you will always see this sort of ins and outs on portfolios, whether you are looking some place like the U.K. or Spain or Germany or Mexico. I don’t think you’ll see -- you know, you are not going to see 12 or 15 of those a year in countries like that for sure, but you can see it occasionally happen.

Joseph T. Buckley - Bear Stearns

What’s your company versus franchise mix in Germany, just roughly?

John W. Chidsey

I think it’s probably close to 15% to 20% in Germany. That’s one of our higher company restaurant markets.

Joseph T. Buckley - Bear Stearns

Okay. Thank you.

John W. Chidsey

It could even be as high as 25 -- I mean, I’d have to go back and look, but --

Operator

If there are no further questions, I will turn the call back to Mr. Chidsey.

John W. Chidsey

Okay, well, first we’d like to thank everybody for your support and interest and just in closing, again I’d like to say we feel great about the momentum going into the fourth quarter here, given the strong April, and we feel great about the 20% plus growth for the year and the fact that we are delivering top of the industry growth, and we look forward to sharing our end of the year results with you post June 30th. Thanks a lot.

Operator

Thank you very much, sir, and thank you, ladies and gentlemen, for your participation in today’s conference call. This concludes your presentation. You may now disconnect. Have a good day.

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